California One-Action Rule Preempted by Federal Debt Collection Improvement Act

Cal. Code Civ. P. § 726, often referred to as the one-action rule, has many facets. Relevant to this article is the “security-first” rule which requires “a secured creditor to proceed against the security before enforcing the underlying debt”; the penalty for failing to do so is waiver of the security.

In practical terms, this means a creditor secured by property has to either pursue foreclosure or file a lawsuit on the debt. The aforementioned ‘or’ is an exclusive ‘or’ meaning the lender has to pick one or the other and cannot pick both options. Consequently, this is what’s typically referred to as an “election of remedies.”

Federal agencies like the Small Business Administration (“SBA”) are allowed to offset debts owed to them by directing the U.S. Treasury Department to pay them monies that would otherwise be paid to a debtor.

So what happens when the SBA is owed money secured by property in California and obtains an offset from the treasury department?  Application of § 726 would mean the SBA would have to waive its security interest. The Debtor would own the property free and clear of SBA’s lien. (Practically speaking, the SBA could then obtain a judgment, an abstract of judgment and record a new lien, but this new lien would be in last place.)

This issue was before the bankruptcy court in case no. Case 9:13-ap-01143-PC (the decision was actually made by Judge Riblet and recently assigned to Judge Caroll). While the bankruptcy court wasn’t clear as to its exact rationale for granting the SBA’s motion to dismiss the action seeking to remove its lien (which left open several basis for affirming the decision), the District Court, acting as an appellate court, didn’t mince words.

Preemption occurs in one of three ways: “(1) Congress enacts a statute that explicitly pre-empts state law; (2) state law actually conflicts with federal law; or (3) federal law occupies a legislative field to such an extent that it is reasonable to conclude that Congress left no room for state regulation in that field.” Chae v. SLM Corp., 593 F.3d 936, 941 (9th Cir. 2010). This is a disjunctive test meaning any of the clauses above, by themselves, are sufficient for the court to apply preemption.

The court found that § 726 is a consumer protection law that implicates contract law and is therefore of the kind typically regulated under state law. Consequently, the only way to preempt it would be through application of the second prong above, which requires a finding that (1) § 726 presents an obstacle to the accomplishment of the purpose of a federal statute and (2) the statute presents a “clear and manifest purpose of Congress” to preempt state law. This is a conjunctive test which requires both prongs to be satisfied.

The offset described above is authorized by the Debt Collection Improvement Act (“DCIA”). Through analysis of the statement of purpose in enacting the DCIA, the court found that Congress intended to regulate the debt collection of federal agencies under a single scheme, which necessarily carries with it the purpose of preempting state law to the degree that it presents an obstacle to the operation of such a federal scheme.

The court found that the purposes of the statute would be thwarted if its mandatory debt collection procedures resulted in the loss of an agency’s security interest under state election-of-remedies rules.

Therefore, therefore, Cal. Code Civ. P. § 726 is preempted.

A copy of the decision may be found on Google Scholar here.